Turkey tantrum? Investors fret over contagion from lira plunge

LONDON (Reuters) - The plunge in Turkey's lira TRYTOM=D3 to a series of record lows over the past week sent tremors through global markets. While the currency has recovered a little lost ground since Tuesday, investors are fretting about contagion via stress on foreign banks and firesales of emerging market assets.

FILE PHOTO: A 100 Turkish lira banknote is seen on top of 50 Turkish lira banknotes in this picture illustration in Istanbul, Turkey August 14, 2018. REUTERS/Murad Sezer/File Photo

The following charts illustrate the fall in the lira and its effect across other asset classes.

1) THE FALLOUT IN SUM

This chart shows the change in assets since the start of the month, capturing the moves in Turkey.

MSCI emerging market stocks .MSCIEF are now down 9.9 percent year-to-date, and continue to drift away from the direction of global stocks on the MSCI World index .MIWO00000PUS. This has also come about as emerging central banks collectively tighten monetary policy.

Analysts are divided over how long and how deep a fallout global markets could experience from Turkey’s currency crisis.

“As long as we talk about idiosyncratic risks such as sanctions on Russia and Turkey’s relations with the U.S. we can’t talk of major contagion,” said Steve Donze at Pictet Asset Management. “To have contagion across EM you need broad based dollar strength.”

2) TAKING STOCK

The tumble in Turkey’s currency rocked local stock markets. In dollar terms, MSCI’s Turkey equity index .MITR00000PTR has lost around 24 percent of its value since the start of August. The index has tumbled more than 50 percent since the start of the year compared with an around 10 percent decline in the broader emerging market index .MSCIEF.

3) SPILLOVER INTO OTHER EMERGING MARKET CURRENCIES

The freefall in the lira has helped to drag down other emerging currencies. Argentina’s peso hit its weakest on record with another emergency interest rate rise doing little to stem the drop. India’s rupee also plumbed a record low, while Russia’s rouble, South Africa’s rand and Indonesia’s rupiah all traded at their weakest in two or more years.

Stuart Culverhouse at Exotix Capital said sellers weren’t just targeting markets which show similarities to Turkey.

“Contagion and risk off are the main themes although we are seeing a generalized selloff rather than the ‘similar characteristics’ theory,” he said.

Wide and widening current account deficits made a number of countries more vulnerable to investors cutting back on risk assets. “On these metrics, Turkey, Argentina and Pakistan are among the most vulnerable,” Culverhouse added.

The falls across the board in emerging market currencies also precipitated a jump in the 1-month implied volatility of these currencies, indicating that investors expect more outsized moves in the coming days.

4) EURO & EURO ZONE BANKS

Shares of European banks .SX7E - particularly those with sizeable operations in, and exposure to Turkey - sold off after reports that the European Central Bank was increasingly concerned about some lenders.

“Spanish lenders are most vulnerable to the worsening currency crisis, followed by French and Italian banks,” noted Shweta Singh at TS Lombard. “With Europe’s large exposure to Turkey through banking sector flows, investors are increasingly worried about the fallout as the crisis unfolds.”

The pressure on European banks also spilled over into pressure on the euro currency, which weakened amid renewed concerns over the stability of the euro zone’s financial system.

The U.S. dollar benefited from safe haven flows as investors exited risky assets and bought into U.S. Treasuries, thought to be the safest assets in the world. The yield on the 10-year U.S. Treasury fell to its lowest in two weeks, while the greenback hit its highest level in a year.

Currencies viewed as safe havens, such as the Japanese yen and the Swiss franc, also gained from the turmoil.

Dollar and U.S. Treasuries benefits as investors flock to safe havens: reut.rs/2OBPlZU

Reporting by Ritvik Carvalho; additional reporting by Sujata Rao in London; editing by David Stamp